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There are two principles of note issue. The first is the currency principle and the second is banking principle. There are different views about these principles. One school of thought says that there should be full convertibility of.

There are two principles of note issue. The first is the currency principle and the second is banking principle. There are different views about these principles. One school of thought says that there should be full convertibility of notes into gold bullion. The second gives importance to the elasticity of supply.

Currency Principle:

According to the advocates of the currency principles, the paper money is an economical and convenient substitute of metal money. They insist that paper money in circulation should be backed by 100% gold reserves. There will always be availability of gold for the redemption of notes when presented which creates stability in price level and exchange rates, because every note issued is covered by gold behind it.

Merits

Safety and Security:

It gives full safety and security to the paper currency.

No Danger Of Inflation:

There is no danger of over-issue of the currency, which is an effective check to the possibilities of inflation.

Public Confidence:

The currency principle provides greater confidence to the public, because it provides assurance in ease of convertibility of notes.

Demerits

Inelastic:

It makes the supply of money highly inelastic, because the issuance of notes is only possible on the availability of gold. So, the government cannot issue notes in case of emergency.

Dependent:

According to this principle, paper currency can only be primed and issued if there is 1009b gold cover available against it. The issuance of currency thus completely depends upon the availability of gold rather than the trade and industry need.

Lock up of Gold:

There is unnecessary lock up of gold for the currency, which may be used for some other purposes.

Real World:

It is not acceptable in the real world and has no support from all over the world.

Banking Principle:

According to this principle, there is no need to have the reserve of gold and silver for the issuance of notes. The banks are authorized to regulate the note issue keeping in view the needs of trade and industry The banks themselves maintain adequate reserves of gold for meeting the obligations of notes. If there is an over issue of notes, the excess money will be automatically presented for cash payment and thus the proper ratio will be maintained between the supply of money and the gold reserves.

Merits

Elastic System:

The banking principle is elastic because gold is not kept for current percent value of notes issued.

Government needs:

This system is fit for meeting the government needs in case of emergencies.

Popularity:

This system is popular all over the world. Every country is issuing money under this system.

Surety:

It also provides surety for the convertibility of notes.

Demerits

Over-Issue:

In order to meet the demand for money, there may be a further issue of notes beyond to a certain limit which leads to inflation.

Economic Crisis:

During economic crisis the convertibility of notes may be refused.

Balance of Payment:

This is not good for keeping the stable exchange rates. Whenever there is a change in foreign, exchange rates, the balance of payment position becomes more unfavorable.